1.2 Scarcity and Choice for the Economy as a Whole
Just as individuals face scarcity and choice, so too does the economy as a whole. The total amount of resources in an economy—workers, land, machinery, and factories—is limited. Thus, the economy cannot produce all the health care, crime prevention, education, or entertainment that people want. A choice must be made. Let us first consider how to represent scarcity and choice in the whole economy and then consider alternative ways to make those choices.
Production Possibilities
To simplify things, let us suppose that production in the economy can be divided into two broad categories. Suppose the economy can produce either computers (laptops, desktops, servers) or movies (thrillers, love stories, mysteries, musicals). The choice between computers and movies is symbolic of one of the most fundamental choices individuals in any society must face: how much to invest to produce more or better goods in the future versus how much to consume in the present. Computers help people produce more or better goods. Movies are a form of consumption. Other pairs of goods also could be used in our example. Another popular example is guns versus butter, representing defense goods versus nondefense goods.
With a scarcity of resources, such as labor and capital, a choice exists between producing some goods, such as computers, versus other goods, such as movies. If the economy produces more of one, then it must produce less of the other. Table 1.1 gives an example of the alternative choices, or the production possibilitiesAlternative combinations of production of various goods that are possible, given the economy’s resources., for computers and movies. Observe that six different choices could be made, some with more computers and fewer movies, others with fewer computers and more movies.
Table 1.1 tells us what happens as available resources in the economy are moved from movie production to computer production or vice versa. If resources move from producing movies to producing computers, then fewer movies are produced. For example, if all of the resources are used to produce computers, then 25,000 computers and zero movies can be produced, according to the table. If all resources are used to produce movies, then no computers can be produced. These are two extremes, of course. If 100 movies are produced, then we can produce 24,000 computers rather than 25,000 computers. If 200 movies are produced, then computer production must fall to 22,000.
Table 1.1 Production Possibilities
| Movies | Computers | |
|---|---|---|
| A | 0 | 25,000 |
| B | 100 | 24,000 |
| C | 200 | 22,000 |
| D | 300 | 18,000 |
| E | 400 | 13,000 |
| F | 500 | 0 |
Increasing Opportunity Costs
The production possibilities in Table 1.1 illustrate the concept of opportunity cost for the economy as a whole. The opportunity cost of producing more movies is the value of the forgone computers. For example, the opportunity cost of producing 200 movies rather than 100 movies is 2,000 computers.
An important economic idea about opportunity costs is demonstrated in Table 1.1. Observe that movie production increases as we move down the table. As we move from row to row, movie production increases by the same number: 100 movies. The decline in computer production between the first and second rows—from 25,000 to 24,000 computers—is 1,000 computers. The decline between the second and third rows—from 24,000 to 22,000 computers—is 2,000 computers. Thus, the decline in computer production gets greater as we produce more movies. As we move from 400 movies to 500 movies, we lose 13,000 computers. In other words, the opportunity cost, in terms of computers, of producing more movies increases as we produce more movies. Each extra movie requires a loss of more and more computers. What we have just described is called increasing opportunity costsA situation in which producing more of one good requires giving up an increasing amount of production of another good., with an emphasis on the word increasing.
Why do opportunity costs increase? You can think about it in the following way. Some of the available resources are better suited for movie production than for computer production, and vice versa. Workers who are good at building computers might not be so good at acting, for example, or moviemaking may require an area with a dry, sunny climate. As more and more resources go into making movies, we are forced to take resources that are much better at computer making and use them for movie making. Adding specialized computer designers to a movie cast would be quite costly in terms of lost computers, and it might add little to movie production. Thus, more and more computer production must be lost to increase movie production by a given amount.
The Production Possibilities Curve
Figure 1.3 is a graphical representation of the production possibilities in Table 1.1 that nicely illustrates increasing opportunity costs. We put movies on the horizontal axis and computers on the vertical axis of the figure. Each pair of numbers in a row of the table becomes a point on the graph. For example, point A on the graph is from row A of the table. Point B is from row B, and so on.
When we connect the points in Figure 1.3, we obtain the production possibilities curveA curve showing the maximum combinations of production of two goods that are possible, given the economy’s resources.. This curve shows the maximum number of computers that can be produced for each quantity of movies produced. Note that the curve in Figure 1.3 slopes downward and is bowed out from the origin. That the curve is bowed out indicates that the opportunity cost of producing movies increases as more movies are produced. As resources move from computer making to movie making, each additional movie means a greater loss of computer production.
Figure 1.3 The Production Possibilities Curve
Each point on the curve shows the maximum number of computers that can be produced when a given amount of movies is produced. The points with letters are the same as those in Table 1.1 and are connected by smooth lines. Points in the shaded area inside the curve are inefficient. Points outside the curve are impossible. For the efficient points on the curve, the more movies that are produced, the fewer computers that are produced. The curve is bowed out because of increasing opportunity costs.
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The vertical axis shows the number of computers produced (in thousands) and the horizontal axis shows the number of movies produced (in the hundreds). The production possibilities curve is bowed out from the origin. The vertical intercept (denoted Point A) is at (0,25) signifying that if all resources are devoted to producing computers, the economy can produce 25,000 computers (and zero movies). The horizontal intercept (denoted Point F) is at (5,0) signifying that if all resources are devoted to producing movies, the economy can produce 500 movies (and zero computers). Points B, C, D and E are labeled as “efficient” because they lie on the border (or frontier) of the production possibilities curve. Point I is located in the interior portion of the production possibilities curve and is labeled as “inefficient”. Point J is located outside the production possibilities curve and is labeled “impossible”.
Inefficient, Efficient, or Impossible?
The production possibilities curve shows the effects of scarcity and choice in the economy as a whole. Three situations can be distinguished in Figure 1.3, depending on whether production is in the shaded area, on the curve, or outside the curve.
First, imagine production at point I. This point, with 100 movies and 18,000 computers, is inside the curve. But the production possibilities curve tells us that it is possible to produce more computers, more movies, or both with the same amount of resources. For some reason, the economy is not working well at point I. For example, a talented movie director may be working on a computer assembly line because her short film has not yet been seen by studio executives, or perhaps a financial crisis has prevented computer companies from getting loans and thus disrupted all production of computer chips. Points inside the curve, like point I, are inefficient because the economy could produce a larger number of movies, as at point D, or a larger number of computers, as at point B. Points inside the production possibilities curve are possible, but they are inefficient.
Second, consider points on the production possibilities curve. These points are efficient. They represent the maximum amount that can be produced with available resources. The only way to raise production of one good is to lower production of the other good. Thus, points on the curve show a trade-off between one good and another.
Third, consider points to the right and above the production possibilities curve, like point J in Figure 1.3. These points are impossible. The economy does not have the resources to produce those quantities.
Shifts in the Production Possibilities Curve
The production possibilities curve is not immovable. It can shift out or in. For example, the curve is shown to shift out in Figure 1.4. More resources—more workers, for example, or more cameras, lights, and studios—would shift the production possibilities curve out. A technological innovation that allowed one to edit movies faster also would shift the curve outward. When the production possibilities curve shifts out, the economy grows because more goods and services can be produced. The production possibilities curve need not shift outward by the same amount in all directions. The curve could move up more than it moves to the right, for example.
Figure 1.4 Shifts in the Production Possibilities Curve
The production possibilities curve shifts out as the economy grows. The maximum numbers of movies and computers that can be produced increase. Improvements in technology, more machines, or more labor permits the economy to produce more.
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If the production possibilities curve shifts outward, this means that the economy was able to produce more computers for a given amount of movie production, and produce more movies for a given amount of computer production. This can occur because of technological innovation or by adding more resources.
As the production possibilities curve shifts out, impossibilities are converted into possibilities. Some of what was impossible for the U.S. economy in 1975 is possible now. Some of what is impossible now will be possible in 2035. Hence, the economists’ notion of possibilities is a temporary one. When we say that a certain combination of computers and movies is impossible, we do not mean “forever impossible,” we mean only “currently impossible.”
Scarcity, Choice, and Economic Progress
However, the conversion of impossibilities into possibilities is also an economic problem of choice and scarcity: If we invest less now—in machines, in education, in children, in technology—and consume more now, then we will have less available in the future. If we take computers and movies as symbolic of investment and consumption, then choosing more investment will result in a larger outward shift of the production possibilities curve, as illustrated in Figure 1.5. More investment enables the economy to produce more in the future.
The production possibilities curve represents a trade-off, but it does not mean that some people win only if others lose. First, it is not necessary for someone to lose in order for the production possibilities curve to shift out. When the curve shifts out, the production of both items increases. Although some people may fare better than others as the production possibilities curve is pushed out, no one necessarily loses. In principle, everyone can gain. Second, if the economy is at an inefficient point (like point I in Figure 1.3), then production of both goods can be increased with no trade-off. In general, therefore, the economy is more like a win-win situation, where everyone can achieve a gain.
Figure 1.5 Shifts in the Production Possibilities Curve Depend on Choices
On the left, few resources are devoted to investment for the future; hence, the production possibilities curve shifts only a little over time. On the right, more resources are devoted to investment and less to consumption; hence, the production possibilities curve shifts out by a larger amount over time.
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Each diagram shows a production possibilities curve with investment goods on the vertical axis and consumption goods on the horizontal axis. The right panel shows that if we choose to invest a lot more today then not only will we get more investment goods today, we will also be able to produce more consumption goods in the future using the investment goods. The left panel shows that if we invest only a little more today then we will end up with only a little more investment goods and only a little more consumption goods in the future.
Review
The production possibilities curve represents the choices open to a whole economy when it is confronted with a scarcity of resources. As more of one item is produced, less of another item must be produced. The opportunity cost of producing more of one item is the reduced production of another item.
The production possibilities curve is bowed out because of increasing opportunity costs.
Points inside the curve are inefficient. Points on the curve are efficient. Points outside the curve are impossible.
The production possibilities curve shifts out as resources increase.
Outward shifts of the production possibilities curve or moves from inefficient to efficient points are the reasons why the economy is not a zero-sum game, despite the existence of scarcity and choice.